Banking expert: Free checking accounts aren't long for this world

The free checking account as we know it is likely at the start of its death throes.

This is according to Hank Israel, a director at Novantas, a consulting firm for the banking and credit card industry and which, last week, was featured in a WalletPop post about credit card rewards. Israel was interviewed on "The CEO Show," a syndicated radio program, predicting the demise of the free checking account, and when I heard about that, I figured I had to talk to him.

I've been griping for some time now on WalletPop that free checking is hardly free. After all, the average household pays more than 12 overdraft charges a year. At, say, $35 a pop, that's $420 a year -- hardly a free checking account. So I was interested to get Israel's take on the evolution of the free checking account, and sure enough, he didn't disappoint. Israel is a font of knowledge on banking.

So here's the main gist of what we talked about.

Banks have to make money somehow. We may not like that they have to make money, but they are a business, after all. Israel sees trouble ahead for the banks when the Federal Reserve gets around to addressing overdraft fees, and notes that banks are already adjusting to new rules, like making it harder for banks to raise credit card interest rates without warning, from the Credit Card Accountability Responsibility and Disclosure (CARD) act. Some of the CARD rules went into effect in August; the rest will start in February. "Some of these regulations are going to limit the banks' ability to charge overdrafts," says Israel, meaning that banks are already trying to think of new ways to make their profits.

Free checking, as a concept, has been kind of milked to death. "Solutions tailored to the crowd that wants a free checking account were probably running out of steam, anyway," says Israel. "Everyone has a free checking account, which when you're a bank, doesn't help you distinguish yourself from the guy across the street. Banks need a value proposition that people are willing to leave their own bank cross the street for."

And that comment I found very interesting. I'm pushing 40, and I remember back in the summer of 1992, being fresh out of college and living in Los Angeles. I opened a Bank of America account, and I remember, as a young man who knew nothing about banks and didn't have a lot of money, anyway, being irritated at being told I needed to keep a minimum amount of money in my bank account to avoid a maintenance fee. So what did I do? I left BofA within the year and found a bank that offered free checking. But that's the thing. There hasn't always been free checking, something that's easy for Generation X and Generation Y to forget or have never known. It's a relatively new concept in banking, and as Israel notes, it may have run its course.

Israel points out that "the checking account really hasn't changed much in a hundred years," but the people who use a bank's checking account have changed. "Checking accounts were originally designed for wealthy people," says Israel, "and it was based on a trust system that you would never overdraw your account."

When wealthy people were keeping thousands upon thousands of dollars, banks, of course, could leverage that into profits from the interest. It's another story when a free checking account consistently has $146 in it.

So banks, says Israel, have to basically do a handful of things to keep their current checking account model profitable.
  • Get more people to sign up for checking accounts. "But the United States' population is only growing at 3% a year, and at only 3% a year, not every bank is going to be able to expand its customer base," says Israel.
  • Get more people to use their debit cards, which means that the bank gets more interchange fees (the small percentage of income that the merchant and/or customer pays to the bank when the card is used).
  • Get people to increase their balances in their checking accounts. Good luck with that during a recession, albeit one that appears to be slowly ending.
  • Raise fees.
So what might the American checking account look like in a few years? Israel thinks it'll look Canadian. Or like a cell phone. Well, actually a little of both. Canadian banks, he says, are a lot like our cell phones are today. You can get a cell phone plan with just enough minutes for a few quick conversations -- to, say, a tow truck service because you've stalled on the road -- or you can pay more and get a cell phone that allows you to text, receive unlimited minutes and surf the web.

Bank accounts may eventually do something similar where, like at a typical Canadian bank, you buy a banking plan that allows you to have a certain number of transactions but nothing else. Or if you want to spend the money, you pay more, for more services.

But the good news is that overdraft fees are likely to go down. This is bad for people who use free checking and, year after year, never have an overdraft fee. But it's good news, of course, for people who can't manage their money as effectively and are constantly being soaked. In other words, the cost of a checking account is likely to be spread more evenly among everyone.

Assuming that happens, and you pay for your bank account depending on the services you use, like a cell phone, protection from overdraft fees are likely to be in the offerings. (In fact, that's already happening. Probity Financial Services, which offers online banking, and which we've written about in WalletPop, is constantly touting the fact that for $19.95 a month, you'll never have to pay an overdraft fee.)

So after the last couple of decades of banks sending the message: "Hey, come to us, we have free checking," banks are likely going to be saying: "Hey, come to us, we can protect you from our overdraft fees."

But to be protected, you will have to pay something. There is no free lunch, and increasingly, there is no free checking account either. Really, for some people, there never was.

Geoff Williams writes a lot about banking for WalletPop. He is also the author of a book (that has nothing to do with banking) called C.C. Pyle's Amazing Foot Race: The True Story of the 1928 Coast-to-Coast Run Across America (Rodale).
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